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Market lacks direction, index performance to remain under pressure

During the week ended 5th October 2018, the benchmark index of Pakistan Stock Exchange (PSX) eroded by 4.32%WoW and closed 39,226 points. Having lost 911 points during the first four trading days, Shahbaz Sharif’s arrest by National Accountability Bureau (NAB) in the Ashiana Housing case on Friday afternoon came as a final nail in the coffin. Deferment of electricity rate hike and lack of direction on potential entry in to the IMF program kept investors on the sidelines, shrinking average trading volume to 113.5 million shares as compared to 124.4 million shares a week ago.

Top volumes leaders included: UNITY, BOP, TRG, FFL and DOL reflecting investor’s interest in second tier stocks. More importantly, banking sector scrips failed to attract investors’ attention despite a 100bps interest rate hike by the central bank in its last monetary policy announcement. Other news flows during the week were: 1) IMF stressing upon more stringent measures including further currency devaluation, interest rate hikes, revenue collection measures and reforms in the PSEs during its article IV consultations with Pakistani authorities, 2) Saudi Arabia expressing interest in investing in Pakistan with an MoU signed for the construction of 500,000 barrel per day (bpd) refinery at Gwadar in partnership with PSO, 3) GoP once again imposing a ban on purchase of automobiles and property by non-filers, 4) OGRA notifying hike in gas rates for different industrial consumers effective 27th September and 5) a sharp drop of US$627million in reserves held State Bank of Pakistan due to the lack on inflow of foreign exchange.

Except HASCOL, no other leading scrip closed the week in green, whereas the losers included: DGKC, MLCF, ASTL, INDU and PSO. Foreigners remained net seller with US$8.42million, marking its 23rd week of outflows. While medium term triggers are centered around policy initiatives to be taken by the GoP, key macro events to drive the market in the upcoming week include 1) development over NAB proceedings in the Ashiana Housing scheme as various statements hint towards more high profile arrests as a follow up and 2) possible clarity over external financing as Finance Minister Asad Umer is expected to attend IMF/World Bank’s annual meeting in Bali. Factoring these, overall index performance can remain under pressure. However, news flows suggesting GoP extending subsidy to the fertilizer sector post gas rate hike should stimulate interest in the sector.

Pakistan’s leading brokerage house, Topline Securities, has reviewed 4QFY18 performance of Pakistan’s cement players that is based on a sample of 13 listed producers, out of a total of 17, representing 97% of total market capitalization of cement companies. Those not included in the sample were those who have not yet announced their results or posted losses. While industry’s net earnings were significantly up by 45% YoY in 4QFY18 thanks to tax benefits, pretax profits fell 36% YoY to a 4-Year low of Rs11 billion. Companies that booked huge tax benefits were ACPL, BWCL and DGKC. Pretax profits were down mainly due to lower gross margins at 6-year low. Gross margins declined to 26.6% in 4QFY18, posting continuousdecline amid increase in production costs due to: 1) higher coal prices, up 30% YoY, 2) increase in Re-Gasified Liquefied Natural Gas (RLNG) cost due to higher international oil prices up 47% YoY, 3) rupee depreciation and 3) weak pricing discipline owing to oversupply concerns on the back of upcoming capacities which also restricted manufacturers ability to pass on increase in Federal Excise Duty (FED)


Gross margins are moving down towards regional average of 20-25%. Aggregate dispatches of the industry during 4QFY18 were up 10% YoY, led by 7% increase in local dispatches and 39% hike in exports. Higher exports can be attributed to: 1) rupee depreciation, 2) additional production from new capacities in South and 3) higher clinker sales to regional countries on the back of closure of some clinker production lines in China owing to strict environmental regulation. Financial charges were up 47% YoY as producers took on more debt to fund their upcoming expansions coupled with rising interest rates. Interest rates have now reached to 8.5% with 2018YTD increase of 275bps. The players reported tax benefit of around Rs9.5 billion on the back of tax credit under 65B of the Income Tax Ordinance, 2001 on account of investment in new cement lines and adjustment of deferred taxes as a result of downward revision in future corporate tax. For FY18, cement manufacturers had posted aggregate profit of Rs54.4 billion, down 4% YoY while pretax earnings fell 25%. Yearly margins were at 6-year low of 30%.

Auto sales remained on the down spree with 8MCY18 passenger car sales increasing by 1%MoM as against 5%MoM increase during 8MCY17. The decline can be attributed to: 1) price hikes of 7 to 12%CYTD for all OEMs on account of rupee depreciation and levies on auto part imports, 2) absence of any new model launches, where the last major launch was the revamped Cultus in April 2017 and 3) the general decline of purchasing power as monetary tightening makes auto financing less attractive. Adding to industry woes, the ban on sale of new vehicles to non-filers was the straw that broke the camel’s back. Bifurcating passenger car demand for the last 23 years by segments highlights the relatively softer cycles for sales growth exhibited by the 1,300CC and above segment. Between FY96-18 four clear cycles can be seen for passenger car sales growth. Taking cues from these trends, analysts believe players in the premium segment will be relatively better off when facing the current bout of dampeners to demand. AKD has revised its sales growth assumption for CY18/FY19 onwards and brought down earnings of PSMC and INDU by 14.5% and 10.2%.

Additionally worrisome developments regarding pricing power hinder earnings growth, prompting a cut in gross margin assumptions to long term average levels of 7.2% and16.3% for two large assemblers due to strong dealer networks, after sales services, add-on features and vehicle availability become mandatory for sustaining market shares. Numerous stakeholders stand to play their part in implementing the ban. Additionally, on the question of new entrants, it follows that they are likely to feel the heat of reduced demand as well.

Developments to be watched closely in the near term are: 1) unintended consequences on pulling LCV sales lower, 2) responsiveness of OEMs to cost pressures, 3) new vehicle/model launches by existing OEMs and 4) ability of assemblers to preserve margins as the long term competitive environment heats up with new entrants having large CKD assembly capacities.

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